BECAUSE THE UNITED STATES was a highly industrialized nation by the 1890s, the depression that began in 1893 brought unparalleled economic suffering to the American population. In 1860 there had been four farm workers for every factory worker, but by 1890 the ratio had dropped to two to one. That meant that one American family in three was now dependent on a regular paycheck for food, shelter, and clothing.
In the spring of that year the Philadelphia and Reading Railroad and the National Cordage Company—the so-called Rope Trust—both unexpectedly declared themselves insolvent, and panic swept Wall Street. The economic carnage quickly spread through the rest of the economy. By the end of that year some fifteen thousand companies had failed, along with 491 banks. The gross national product fell by 12 percent, and unemployment rose rapidly from a mere 3 percent in 1892 to 18.4 percent two years later.
Until the 1870s the very word unemployed had applied to anyone without an occupation, from five-year-old children to housewives to people who lived off the income of their investments. But in 1878, as the depression of that decade was ending, a Massachusetts survey redefined the unemployed to mean men over eighteen who were “out of work and seeking it.” By the mid-1890s they numbered in the millions, and hunger stalked the streets of the now vast slum districts of American cities, while only private charities were available to alleviate the misery.
The immediate cause of the new depression—as in most previous ones in this country—had been overexpansion due to the lack of a central bank to tap the brakes when needed. But there was also an underlying cause: a monetary policy that tried to do two incompatible things at the same time.
THE YEAR FOLLOWING THE GOLD PANIC of 1869, the House of Representatives had held hearings on the matter. Chaired by Representative James A. Garfield, the hearings first brought the Ohio congressman to national prominence. Garfield, the soundest of sound-money men, wrote in the report the committee issued that “So long as we have two standards of value recognized by law, which may be made to vary in respect to each other by artificial means, so long will speculation in the price of gold offer temptations too great to be resisted.”
Garfield, in other words, wanted to return to the gold standard and retire the greenbacks. The merchants dealing in international trade, many of whom had seen ruin staring them in the face on Black Friday, also wanted to return to the gold standard. So did Wall Street’s increasingly powerful banks and those who were involved in the country’s heavy industry. These were, of course, the people who by then dominated the Republican Party. But there were many more who opposed a return to the gold standard.
The gold standard has one big advantage as a monetary system: it makes inflation nearly impossible. If a country increases its paper money supply beyond what the market will bear, holders of banknotes will begin turning them in for gold, and gold will move abroad as foreign central banks begin not to trust the currency and cash it in for what they do trust: gold.
But inflation is always popular with debtors because it allows them to repay their debts in cheaper money. And in areas like the devastated South, whose banking assets and other liquid wealth had been largely destroyed in the war, a monetary system based on the gold standard meant continued depression, whereas “easy money” would have helped revival. In fact, the late nineteenth century was marked by a very slow but steady deflation.
As a result of its effects, the gold standard was popular in the Northeast, where finance, foreign trade, and industry were centered, but unpopular among small farmers on the frontier and in the South. There, much of the population regarded the gold standard as nothing more than a plot by “Wall Street” to drive them into bankruptcy. In 1876 the Greenback Labor Party nominated a candidate for president (the aged Peter Cooper of New York, paradoxically one of the richest men in the country; he was, perhaps, the very first “limousine liberal”). In 1878 the party attracted 1,060,000 votes in congressional elections, enough to elect fourteen congressmen.
Although the government had stopped printing greenbacks (other than to replace those worn out by use) at the end of the Civil War, it minted silver dollars out of the rapidly increasing amounts of silver being mined in the West, giving the country a “bimetallic standard.” Then, in 1873, it stopped minting these dollars as Congress voted to return to the gold standard by 1879. This was immediately labeled, by those who opposed the gold standard, “the crime of ’73.” Both sides of the issue put unrelenting pressure on Congress, which, as democratic legislatures usually do, especially when dealing with complex and abstruse economic issues, tried to have it both ways.
The country returned to the gold standard on schedule, on January 1, 1879, and the Treasury was required to maintain a gold reserve of $100 million to meet any demand for the precious metal. The previous year, Congress had voted to keep the $346,681,000 worth of greenbacks that were still in circulation, but made them redeemable in gold, as were the silver coins. Further, it had also passed the Bland-Allison Act. This required the Treasury to purchase between $2 million and $4 million a month of silver on the open market and turn it into coin at a ratio of sixteen to one with gold. In other words, Congress declared by fiat that sixteen ounces of silver were worth the same as one ounce of gold. This new silver coinage, of course, had the effect of considerably increasing the country’s money supply, the classic recipe for inflation.
At first, sixteen to one was approximately the actual price ratio between gold and silver. But as the great silver strikes in the West, such in Coeur d’Alene, Idaho, and the fabulous Comstock Lode in Nevada, first discovered in 1859, came into production, the price of silver began to drop in the marketplace. By 1890 it had reached about twenty to one. That year, Congress passed the Sherman Silver Act, mandating that the Treasury buy 4.5 million ounces of silver a month, just about all the silver the country was producing, and coin it.
With the gold standard keeping the value of the dollar steady, while the silver policy greatly increased the money supply, the government managed, in effect, both to guarantee and to forbid inflation. Inevitably, Gresham’s law kicked in. With silver worth one-twentieth the price of gold in the market but one-sixteenth the price when coined as money, people naturally spent the silver and kept the gold, which began to trickle out of the Treasury.
In the 1880s the government was running very large budget surpluses, which masked the schizophrenic monetary policy. But when the crash of 1893 marked the onset of a new depression, the trickle of gold out of the Treasury rose to a flood. As government revenues plunged—they declined from $386 million to $306 million between 1893 and 1894—Congress hastily repealed the Sherman Silver Act. But people and, more importantly, foreign governments had lost faith in the dollar, and the demand for gold at the Treasury increased markedly. The government issued bonds to buy more gold to replenish the gold reserve, but the metal continued to flow out.
Before long the situation was critical. The Treasury gold reserve dipped below the $100 million required by law in 1894 and was replenished by the proceeds of a $50 million bond issue in January of that year. But it fell to just $68 million the following January. A week later it was down to $45 million. Congress refused to allow President Cleveland, a staunch supporter of the gold standard, to sell another bond issue to replenish the vanishing gold reserve.
The government was paralyzed. Soon it was possible to almost literally watch gold flee the country as bullion worth millions of dollars was loaded on ships in New York and headed for European central banks. Bets were being made on Wall Street as to exactly when the Treasury would run out of gold and the country would be forced off the gold standard.
Badly alarmed, J. P. Morgan, by then the country’s undisputed leading banker, took the train to Washington to see that that did not happen. President Cleveland, while personally a backer of sound money and the gold standard, was all too aware that he headed a party a large element of which both wanted the country to be rid of the gold standard altogether and hated “Wall Street” and all its works. He refused to see Morgan. But with the situation deteriorating by the hour, Cleveland decided the next morning that he had no choice but to hear what Morgan had to say.
The president still had hopes that he could persuade Congress to authorize a new bond issue, but that, of course, would take time. A clerk informed Cleveland that the subtreasury in New York had only $9 million in gold remaining in its vaults. Morgan said that he knew of drafts for $12 million that might be presented to the Treasury at any moment. If that happened, he warned, “It will be all over by three o’clock.”
“Have you anything to suggest?” Cleveland, out of options, asked. Morgan did. Issuing more bonds in the domestic market, he argued, would do no good in the long term anyway as the gold would simply recycle back out of the Treasury. But he and August Belmont, Jr., the American representative of the Rothschilds, who was also present at the White House that day, would raise $100 million in gold in Europe that would stem the run on the Treasury. More, Morgan’s lawyers had uncovered an obscure Civil War–era law, still in force, that allowed the government to issue bonds with which to buy coin without further congressional action.
Astonishingly, Morgan was willing to guarantee that the gold would not flow back to Europe, at least in the short term. It was an extraordinary act of financial courage. But thanks to Morgan’s already awesome reputation, and the use of sophisticated foreign exchange techniques, he was able to keep his word. In June 1895 the Treasury’s gold reserve stood at $107.5 million. More important, economic recovery had begun. Morgan had saved the gold standard.
Morgan and Belmont, needless to say, were vilified by the enemies of the gold standard, and the Democratic Convention of 1896 was dominated by them. William Jennings Bryan, a former congressman from Nebraska, now editor in chief of the fiercely pro-silver Omaha World-Herald, gave the delegates the red meat they craved on the issue in one of the most famous speeches in American history.
Bryan assured the delegates at the outset that “The humblest citizen in all the land, when clad in the armor of a righteous cause, is stronger than all the hosts of error.” His cause was the abolition of the gold standard, and he laid out in sonorous prose how it harmed the interests of the farmers and laborers and served only the interests of, in Thomas Carlisle’s phrase, “the idle holders of idle capital.”
That was the great question, he told the delegates. “Upon which side will the Democratic Party fight—upon the side of ‘the idle holders of idle capital’ or upon the side of ‘the struggling masses’?”
As his magnificent voice reached effortlessly to every corner of the convention hall in Chicago, he held the audience in the palm of his hand as he reached the end. “Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests, and the toilers everywhere, we will answer their demand for a gold standard by saying to them, You shall not press down upon the brow of labor this crown of thorns; you shall not crucify mankind upon a cross of gold.”
The delegates went wild upon the conclusion of what the novelist Willa Cather—who was present—called “that never-to-be-forgotten speech.” For half an hour pandemonium reigned, and in the end Bryan was nominated for president at the age of only thirty-six. He remains to this day by far the youngest man ever to be nominated by a major party.
William McKinley, the Republican nominee, campaigned from his porch in Canton, Ohio, giving speeches to crowds brought in by train. Bryan, on the other hand traveled indefatigably on the first whistle-stop campaign in American history. The line between the two parties could not have been sharper. The Populists, moreover, more radical than the Democrats, endorsed Bryan rather than fielding their own candidate.
“We have petitioned,” Bryan had declared in his great speech, “and our petitions have been scorned; we have entreated, and our entreaties have been disregarded; we have begged and they have mocked when our calamity came. We beg no longer; we entreat no more; we petition no more. We defy them!”
Meanwhile a Republican newspaper editorialized that “The Jacobins are in full control in Chicago [where Bryan was nominated]. No large political movement in America has ever before spawned such hideous and repulsive vipers.”
The candidates, as always, left the name calling to their supporters. But Bryan’s economic ideas seriously alarmed even many Americans of modest means and many more with personal ambitions. Many eastern and midwestern Democrats, alarmed at what they regarded as Bryan’s rabble-rousing, supported McKinley.
Early in the campaign, however, it looked like Bryan’s platform might be a winning formula. The Dow-Jones Industrial Average, developed just that spring by Charles Dow, editor of the young Wall Street Journal, to measure the stock market as a whole, slumped by a third over the course of the summer.
Then the economic recovery from the depression picked up steam as summer advanced, greatly helping the party that ran on the slogan of “Sound Money, Protection, and Prosperity.” The Dow-Jones, a rough barometer of the political as well as financial weather, recovered as fall continued.
In November McKinley won with 52 percent of the vote, sweeping the wealthiest and most economically developed parts of the country: the entire Northeast and Middle West, along with the Upper Plains states, plus California and Oregon. Bryan took the South and the rest of the western states.
Many of the Democrats who had abandoned Bryan for the more conservative McKinley never came back. The Republicans would be the majority party for the next generation, losing the White House only when the GOP split in 1912.
But Bryan, while losing (he would lose again in 1900 and 1908, dragging a cross of gold through the political wilderness) identified clearly the future of American national politics. “The sympathies of the Democratic Party,” he had told the delegates in his speech, “…are on the side of the struggling masses who have been the foundation of the Democratic Party. There are two ideas of government. There are those who believe that, if you will only legislate to make the well-to-do prosperous, their prosperity will leak through on those below. The Democratic idea, however, has been that if you legislate to make the masses prosperous, their prosperity will find its way up through every class which rests upon them.”
The choice was clear, but the country, in fact, chose both approaches. American politics is the politics of the center, not the extremes, and this country is given to splitting differences or, when possible, having it both ways at once. Over the next hundred years, as political dominance was enjoyed by each party in turn, the country would employ both trickledown and trickle-up economic policies. The result has been nearly wholly salutary, if, as politics in a democracy always is, philosophically untidy.
OTHER THAN THE GOLD STANDARD, no issue so involved the body politic in this peaceful era as that of taxation. The federal government had relied on the tariff as its principal source of revenue from the days of Alexander Hamilton until the Civil War forced it to tax everything that it could, including incomes.
With the wartime revenues no longer needed after victory, many of the new federal taxes were cut or eliminated. The tariff, however, was not. The greatly enlarged industrial base had grown nestled in the protective bosom of the tariff, and it fought fiercely to maintain it. Meanwhile, the longtime locus of opposition to a high tariff, the South, had lost all political influence until the end of Reconstruction in the late 1870s. By then the idea of high tariffs was Republican Party doctrine. No matter how mature and efficient American industry became—and by the turn of the century it was the most efficient in the world—the managers, stockholders, and workers of industrial companies all fought fiercely and successfully to maintain the tariff at a level far above the government’s revenue needs.
As a result, the government ran a string of twenty-eight straight surpluses beginning in 1866, unparalleled in American history. In the prosperous year of 1882, government revenues ran ahead of outlays by a staggering 36 percent. By the turn of the century the huge Civil War debt had been cut by nearly two-thirds in absolute dollars, and as a percentage of GDP had dropped more steeply still, from about 50 percent to well under 10 percent.
The Civil War income tax had been cut in 1867 to a uniform 5 percent on incomes more than $1,000. Three years later the rate was reduced again, and in 1872 the tax was eliminated altogether. There had been little if any advocacy of an income tax before the Civil War, but all government programs, once established, develop a political constituency, and the income tax was no exception.
Its advocates had logically if not politically compelling arguments on their side. Indirect taxes, such as excise taxes and the tariff, are taxes on consumption and are thus inescapably regressive. That is to say they fall most heavily on those least able to afford them. The poor necessarily spend a far higher percentage of their incomes on necessities than do the rich and therefore pay a far higher percentage of their incomes in these consumption-based taxes.
Senator John Sherman, Republican of Ohio, and no radical by a long shot, explained it in the debate over eliminating the income tax in 1872. “Here we have in New York Mr. Astor,” he said, “with an income of millions derived from real estate…and we have along side of him a poor man receiving a thousand dollars a year. What is the discrimination of the law in that case? It is altogether against the poor man—Everything that he consumes we tax, and yet we are afraid to tax the income of Mr. Astor. Is there any justice in it? Why, sir, the income tax is the only one that tends to equalize these burdens between the rich and the poor.”
Sherman was right. But, as always with taxes, it was political power, not equity, that prevailed. The congressmen of seven northeastern states, which collectively paid about 70 percent of the income tax, voted sixty-one to fourteen to eliminate the tax, while fourteen southern and western states, which paid only 11 percent of the tax, voted five to sixty-one to retain it. In other words, support for the income tax was almost perfectly inversely correlated with its local impact. In a democracy, politicians will always try to follow the dictum usually credited to Senator Russell Long of Louisiana: “Don’t tax you, and don’t tax me, tax the man behind the tree.”
The advocates of an income tax did not make much headway in the prosperous 1880s, but when the great depression of the 1890s struck, and federal revenues plummeted, there were renewed calls for an income tax. With a Democrat, Grover Cleveland, in the White House, and Democratic majorities in both houses of Congress, a new income tax became law in 1894.
It was a very different tax in its impact than the Civil War income tax. The latter had exempted only the poor. The new tax, which called for a 2 percent tax on all incomes more than $4,000, exempted all but the rich. Of the twelve million American households in 1894, only eighty-five thousand had incomes of $4,000 or more. That was well under 1 percent of all households. For the first time in American history, a tax was proposed on a particular class of citizens, one defined by economic success. For that reason, nearly all Republicans opposed it, including Senator Sherman. For that reason as well, Cleveland allowed the bill to become law without his signature.
Not surprisingly, a lawsuit was immediately brought. The plaintiffs argued that an income tax violated the clause in the Constitution that required that direct taxes be apportioned among the several states according to population, something that was obviously impossible with an income tax. The Constitution does not define what constitutes a “direct tax” (Rufus King had asked for a definition during debate in the Constitutional Convention and received no reply). In 1796 the Supreme Court had ruled that a direct tax was any tax that could be apportioned on the basis of population. As recently as 1881 the Court had ruled that the Civil War income tax was an indirect tax.
Regardless, with one member of the Court absent due to illness, the Court split four to four on the question of whether an income tax was a direct tax and thus whether it was constitutional. The case, Pollack v. Farmers’ Loan and Trust, generated enormous interest around the country, far more than Plessy v. Ferguson, which upheld the separate-but-equal doctrine of segregation, did the next year. Because of the intense public attention, the Court agreed to a rehearing of the case, and Justice Howell Jackson, who was mortally ill—he died less than three months later—attended, undoubtedly intent on being the fifth vote to uphold the tax.
One of the other justices (it is not quite clear which, but most likely Justice George Shiras) switched sides, however, and the income tax was ruled unconstitutional, five to four. The eastern Republican establishment had prevailed, if just barely. But over the next few years, a progressive wing rapidly developed in the Republican Party, centered in the Midwest and West, and far more sympathetic to the interests of middle-class citizens. The progressives backed an income tax.
When Theodore Roosevelt became president in 1901 on the assassination of William McKinley, he moved sharply in the direction of the progressive wing of his party. In 1906 he even advocated a tax on inheritances with the avowedly social-engineering purpose of preventing the “transmission in their entirety of those fortunes swollen beyond all healthy limits.” Mainstream Republicans were, to put it mildly, aghast at the idea, but there was no real threat to the status quo until the panic of 1907 and the short recession that followed, which caused government revenues from the tariff to decline sharply.
During the debate on the tariff bill of 1909, Representative Cordell Hull of Tennessee (later Franklin Roosevelt’s secretary of state) proposed reenacting the income tax of 1894 and, in effect, daring the Supreme Court (which, thanks to Theodore Roosevelt’s appointments, was far less conservative than it had been fourteen years earlier) to nullify it a second time.
Hull’s amendment failed to pass the House, but events conspired in the Senate to change matters. A Democratic senator, Joseph W. Bailey of Texas, introduced the income tax amendment in the upper house, supported by such Republican progressives as William E. Borah of Idaho. Leading the forces opposed to the amendment was Senator Nelson W. Aldrich of Rhode Island. Aldrich, who had made a fortune in the wholesale grocery business and was the father-in-law of John D. Rockefeller, Jr., was one of more than twenty millionaires in the Senate at that time.
Aldrich managed to keep the high, protective tariff intact, but the Republicans were hopelessly split on the matter of an income tax, and Aldrich appealed to the new president, William Howard Taft, to find a solution.
Taft, a far more conservative man than Roosevelt, revered the Supreme Court. Indeed, he would serve as chief justice, an office far more congenial to his nature than the presidency, for most of the 1920s. He was horrified at the idea of defying the ruling of the Court in Pollack. He felt that if the Court acquiesced, its status as the arbiter of the Constitution would be gravely impaired, and if it again struck down the income tax, a crisis between the Court and the two popularly elected branches of the government might result.
So Taft, a very gifted lawyer, proposed an alternative. Taft called for a constitutional amendment that would specifically permit a personal income tax, and meanwhile proposed a corporate income tax on profits. At that time the stock of corporations was owned almost entirely by the very affluent, so a tax on corporate profits was, in effect, a tax on the incomes of the rich. Further, he argued, the tax would not run afoul of the Constitution because it was not actually an income tax at all, but an indirect tax, measured by income, on the privilege of doing business as a corporation. In other words, it was an excise tax. In 1911 the Supreme Court agreed unanimously.
The Sixteenth Amendment, meanwhile, passed the Senate 77–0 and passed the House 318–14. The amendment was ratified by the required number of state legislatures and was declared effective on February 3, 1913.
By that time the Republican Party had split between the conservative Taft Republicans and the progressive Roosevelt Republicans, who stormed out of the 1912 convention to form their own party under the symbol of the bull moose. As a result, the Democrat Woodrow Wilson was elected president with less than 42 percent of the popular vote but with almost 82 percent of the electoral votes. Further, the Republican split had produced solid Democratic majorities in both houses of Congress. Among the first acts of the new Wilson administration was the passage of a personal income tax law.
Although almost comically short by later standards—the law was only fourteen pages long—it contained the seeds of the vast complexity that was to come. Income more than $3,000 was taxed, on a progressive scale from 1 to 7 percent (on incomes more than $500,000, then a vast sum indeed). But there were many exemptions, such as interest on state and local bonds and corporate dividends (up to $20,000). Interest on all debts, depreciation of property, and many other things were deductible from taxable income.
And the corporate income tax, originally intended as only a stopgap, was not merged with the personal tax but remained a completely separate tax. The financial exigencies of the twentieth century’s great wars would send income tax rates soaring to heights undreamed of by even its most passionate advocates. As the tax rates bit more and more, accountants and lawyers would begin to find endless ways to shelter income by exploiting the lack of coordination between the two tax systems.
IN THE EARLY YEARS of the twentieth century the United States enjoyed a prosperity beyond anything previously experienced. In the ten years between 1897 and 1907, American exports doubled, as did its imports. The amount of money in circulation—national banknotes and gold and silver coins—increased from $1.5 billion to $2.7 billion, while bank deposits soared from $1.6 billion to $4.3 billion—a figure larger than the gross domestic product in 1860. The assets of banks, brokerage houses, and insurance companies increased from $9.1 billion in 1897 to $21 billion ten years later. The rest of the developed world was also enjoying great prosperity.
But there was a problem. With the world on the gold standard, national economies could grow, at least in the long term, only as fast as the gold supply that backed the world’s currencies. Gold production had stagnated in the 1880s, but as new finds in the Yukon and, especially, South Africa, came into production in the next decade, the supply grew rapidly. Only $157 million in gold was mined in 1893, but $287 million was pulled from the ground five years later. Production grew to more than $400 million in the first years of the twentieth century, but then stagnated at that level, while the world economy continued to grow rapidly.
Demand for capital to finance consolidations of industries grew (as did the need for governments to finance wars such as the Boer War and the Russo-Japanese War). By 1907 money markets were very tight and growing tighter. James J. Hill, who controlled the Northern Pacific Railroad, began warning of what he called “commercial paralysis” if capital became too costly. By early 1907, even one-year gilt-edged bonds could only be sold if they carried coupons paying 5 to 7 percent, very high rates by the standards of the day. Long-term bonds could not be sold at all.
In March the stock market briefly collapsed but then recovered. Stock markets in other countries, especially Egypt and Japan, also shuddered that spring. Gold began to flow out of the United States as the Banks of England and France sought to shore up their positions and prevent runs on their currencies. The United States, of course, without a central bank since Andrew Jackson, had little if any control over its own money supply.
On October 10, in the wake of an attempted corner in copper stocks, panic hit Wall Street. It soon spread to the banks that had been involved in financing the corner, especially the Knickerbocker Trust. A run began on the Knickerbocker, and soon other banks were under siege as well, as depositors sought to convert their assets to cash while they could. The line outside the Knickerbocker’s handsome new headquarters on Fifth Avenue was soon two blocks long. On Wednesday, October 23, the Lincoln Trust bled $14 million in deposits in just a few hours. Other banks were also near to being forced to close their doors.
There was little that the federal government could do. The secretary of the treasury, George B. Cortelyou, came to New York and deposited $6 million in New York banks to add to their liquidity, but the law forbade federal deposits in any but national banks. It was the trust companies and the state banks that were in the most trouble.
Cortelyou did the only thing he could do under the circumstances: he told J. P. Morgan that the federal government would do anything it could to stem the panic and, in effect, relied upon him once again to find a solution to a national financial crisis.
Morgan knew exactly what the problem was. On Thursday, October 24, he told reporters that “if people will keep their money in the banks, everything will be alright.” But getting the people, seized by fear, to cooperate was the hard part.
Morgan realized that the Knickerbocker Trust was beyond salvation but that another trust company, the Trust Company of America, while under attack, was basically solvent. “Then this is the place to stop the trouble,” he decided. He had Cortelyou deposit $35 million in national banks and told those banks to lend the money to the Trust Company of America. When its depositors had no trouble withdrawing their money, of course, they no longer wanted to withdraw it. The panic at the Trust Company of America ended.
But the situation remained perilous. On Thursday the president of the New York Stock Exchange crossed Broad Street to the Morgan Bank to tell Morgan that the exchange would have to close as call money (lent by brokers to finance margin accounts) simply could not be found. Morgan flatly forbade the exchange to close and raised $27 million among the bankers in five minutes to keep it open. That night he called the bankers to his new and magnificent library on Thirty-sixth Street, and they devised a plan to maintain liquidity, shore up solvent banks that were under attack, and provide more call money to the brokers. He let it be known that anyone selling short to take advantage of the panic would be “properly attended to.” Not many brokers wanted to find out exactly what that might mean.
It was a very near-run thing, but the New York financial market managed to get through the rest of the week without another failure. Having summoned the bankers during the week, Morgan now summoned the city’s clergy and urged them to give encouraging sermons that Sunday.
Slowly the panic began to abate, and in another week the worst was over. Many of New York’s bankers, such as James Stillman and George F. Baker, had contributed materially as well as financially to staving off disaster. But it was generally acknowledged that only Morgan, by then the most powerful banker in the world, perhaps the most powerful banker who had ever lived, had been capable of holding the entire Wall Street community together and getting it to act for the common good.
Even Theodore Roosevelt, so fond of railing against the “malefactors of great wealth,” praised “those influential and splendid business men…who acted with such wisdom and public spirit.”
Thanks to Morgan and the other New York bankers, the crash of 1907 did not mark the onset of a period of severe depression, as the crashes of 1873 and 1893 had. But it did make clear that the country simply could no longer do without a central bank. A man of the stature and probity of J. P. Morgan might be able to avert financial calamity in the future, but there was no guarantee that there would be such a man available. Morgan himself was already over seventy. Still, it took six long years of intricate negotiations to get political agreement on the creation of the Federal Reserve System.
All national banks were required to be members of the new central banking system, and state banks that could meet the capital requirements of national banks (very few of them could) were eligible for membership as well. The advantage of membership, of course, was that in a panic, member banks could use their loan portfolios as collateral to obtain cash in a hurry from the Federal Reserve and thus abort any run. The downside of membership was a new layer of regulation added to, rather than replacing, the older regulatory bodies, such as the Comptroller of the Currency.
And the practical effect was that the banks that most needed discipline and protection against runs were the very banks that did not join the system: the small, stand-alone rural banks. By 1920 these fragile vessels holding the liquid assets of millions of American families and businesses would number almost thirty thousand. They were a disaster waiting to happen.
The new Federal Reserve System came into existence in 1913, and the United States had a central bank, if a flawed one, for the first time since Andrew Jackson had been president. It is one of the great coincidences of American economic history that J. P. Morgan, the country’s de facto central banker in much of the post–Civil War era, had been born in 1836, the same year as the charter of the Second Bank of the United States expired. And he died the same year the Federal Reserve, its long-needed replacement, was born.
THE FIRST YEARS of the twentieth century seemed to those alive at the time as the dawn of a new era of progress and prosperity in this country. The country was advancing economically and socially as never before. The United States had one-third of the world’s railroad mileage and 40 percent of its steel production. It was the world’s greatest exporter of agricultural products. Its per capita income was far ahead of the next richest nation, Great Britain, which had dominated the world economy in the nineteenth century.
The greatest engineering project in history, the Panama Canal, had linked the two oceans on which the nation fronted. The Wright brothers had conquered the air. Automobiles were beginning to replace the horse as the chief means of local transportation.
Ninety percent of the American population was literate and supported more than twenty-two hundred newspapers. The country had a thousand colleges and universities and more high school students than any other on earth.
And this bounteous land, while connected as never before by steamer and telegraph cable, was still far from Europe and its increasingly rancorous international politics and dangerous arms race. The United States Army was among the smallest of those fielded by the major powers, but with the wide Atlantic and the world’s third largest navy to insulate it, the country felt secure from whatever might happen in the Old World.
In fact, however, those years proved to be not the dawn of a new era but the golden twilight of an age that was ending. The Victorian age, with its Edwardian coda, had been characterized by a profound belief in the possibility of progress and was, more than any other in history, an age of optimism. That optimism would be among the major casualties of what the diplomat and historian George Kennan correctly called “the seminal catastrophe of the twentieth century,” the First World War.
Another casualty would be American innocence and the belief that the New World could remain remote from the troubles of the Old. As Europe plunged into fratricidal war in the late summer of 1914, just as the Panama Canal was opening for business, the New York Times editorialized smugly that “The European ideal bears its full fruit of ruin and savagery just at the moment when the American ideal lays before the world a great work of peace, goodwill and fair play.”
But less than three years later, an American in Paris would tell the Old World that “America has joined forces with the Allied Powers, and what we have of blood and treasure are yours…. [W]e pledge our hearts and our honor in carrying this war to a successful issue. Lafayette, we are here.”
In all senses except the calendrical, the twentieth century began on August 1, 1914.